A blog of the NYU Colloquium on Market Institutions and the Leipzig Colloquium on the Market Order

Liberty by Design

Those of us who love liberty and fear the state support “deregulation.” We want to unwind the bramble of regulations constraining the dynamic entrepreneurial economy. But we have not thought enough about how to unwind the unwieldy regulatory apparatus of the current system. It is one thing to show how a “truly free market” would work. It is quite another to show how to get from the current regulatory mess to something we are happy call a “free market.”

Most economists agree, for example, that licensing restrictions for physicians serve doctors better than patients. There is less agreement on what to do about it now that we have it. Simply lifting all restrictions immediately seems likely to create a “transition period” in which quacks and charlatans would prey on innocent patients. The market would eventually work out mechanisms to ensure that we all get good care, but how much harm would be done in the “adjustment period” of the economist’s blackboard model? We need to unwind it, but we don’t know how.

Vernon Smith has shown us how to design markets. The process begins with blackboard theory. You work out the right design for your market relying only on economic theory. Then you “test-bed” your design in the experimental economics laboratory. Your design will probably be a flop in the lab, but that failure will teach you how to improve it. Once you have finally worked out a design that makes sense on paper and works in the lab, you are ready to give it a test run out there in the real world.

Adjustments based on experience may still be necessary, but your lab-tested design will be functional and relatively easy to perfect. If you design the market, it may work. If you do not, the market will fail.

Transition Russia illustrates the dangers of undersigned deregulation. The collapse of the Soviet system let to a kind of “free market,” but one that had not been designed in advance. The result has been a “demographic disaster” marked by declining life expectancy. You might object that Russia did not have a “true” free market any more than Stalinism was “true” socialism. But if you don’t design liberty, that’s the risk you run.

Which brings me to my plea. I would ask my fellow lovers of liberty to do less complaining about the evils of state control and more designing of markets and of the other institutions of a truly free society. My work on improving forensic science in the criminal justice system is an example outside the usual context of “deregulation.” (See here and here.)

Our social system evolved as a mixed system in which the state played an active, if often unfortunate, role. What would have happened without the dead hand of the state did not happen. Thus, we have a social system in which people do (because they must) rely on the state for services that would have been provided privately if the system had grown up without an activist state. Such services include more than “welfare.”

They include, for example, systems for signaling quality of physicians. They include all the services that well functioning markets would provide if only we would let them. Simply pulling the plug now would throw lots of people into a difficult spot not of their own doing, which is neither fair nor good. We need to think more rigorously about how to back off the interventionist state. We need to design the institutions of a free society because we did not let them grow up naturally in the past. What would have grown did not. Now we need liberty by design.

A strange thing happens if you get serious about liberty by design. Old divisions between moderates, minimal statists, and anarchists begin to fade away. Our designs for liberty will be implemented by replacing current systems with our designed system. The process of replacement is necessarily a political process and therefore, in the US, a democratic one. Designs for liberty become designs for political reform. The set of designed systems that will replace the current system is a state-sponsored reform. It becomes a matter of taste whether we declare the state to have been removed or reformed. And that’s a good thing. The point is not whether we do or do not have “intervention” or a “true free market,” whatever those empty terms might mean. The point is whether we have liberty, justice, and prosperity. We can have them, but only by design.

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28 thoughts on “Liberty by Design”

Your good questions overlap to some extent with the project we undertook in the Free Nation Foundation, 1993-2000.

I would like to learn how you would sort your alliances. All who enter the arena may say they favor liberty. But almost all may say that first — of course — government must do something more. I believe that policy options will be limited in western democracies as presently constituted. We will see bills that flaunt a few tokens of liberty. But in net these bills will increase the size or scope of the state.

That’s a provocative and insightful post. As you mention, talking about “liberty by design” is the surest way to alienate those of us who see the free society as a spontaneous order that cannot be planned in anyway.

Your point, however, merits reflexion. You are specifically addressing the issue of transition from one system to another and argue that in such a context there is room for design because of various problems associated with losses of rents, Tullock’s transitional gains traps, etc.

One important issue is that the emergence of rules in society is not an overnight process. It is more akin to the acceptance of money as a common medium of exchange. It takes time before a commodity becomes accepted by everyone. Jack High has a recent paper in the QJAE on the subject in which he compares the rise of rules and institutions with that of money. Many of these rules that reduce the problem of fractionalization and enable cooperation among strangers don’t emerge overnight. So you are right to say that removing regulations that have taken the place of these rules is often disastrous. We don’t know how to replicate this. In a similar context, Elenor Ostrom thinks that we know what conditions are necessary for the emergence of rules to govern the commons but there is not certainty as to whether they are sufficient (they may not even be always necessary). It is basically impossible to fully replicate that process.

While you have a point, it is also the case that the transition examples you mention were undermined by many other policy errors. Viktor Gerashchenko did not rein in inflation during the early 1990s as he had supposedly committed to do. As Peter Boettke argues in his book on the failed Russian transition, a lot of what happened was failure to commit on the part of government, which led to disastrous regime uncertainty. Moreover, you have other examples where radical policy changes did bring rapid transformation in society. The deregulation of the NZ manufacturing and agriculture sectors were not done after setting up experiments in a lab but simply on account of a fundamental market liberalization approach.

My take is that while you may have a point, you may also give too much credit to the capacity of anyone to design complex systems. You also underestimate the public choice issues that arise when markets are designed in a transition such as it was the case in the electricity case in CA and also in other countries such as NZ. Moreover, electricity markets may be simpler to experiment in a lab than more others, but that’s not even true. One of the secrets of the success of the NZ reform back in the early 1990s was the idea of “striking fast and wide” before anyone could react. This is the way Roger Douglas was able to pass some of the most daring reforms the Western world has seen in the last 40 years. I would say the same was true of what Margaret Thatcher did in GB. Now I agree that this does not necessarily tell us how to remove licensing restrictions without putting many people in difficulty. You have a point.

Excellent points! Something I’ve been trying to harp on for a while, albeit with much less eloquence. This is one of the things we should be working on.

I have two points I’d make on this issue:

1. A fruitful direction to take would be to think about ways to make state services obsolete. Many of us hate to admit it, but an important reason people don’t get rid of the state, or much of it, is that it provides genuine services. It doesn’t usually do this well, but so long as it is the only provider it often verges on the Nirvana fallacy to say “abolish the state (or state activity) and the market will take care of it.” Actual alternatives, esp. things that can be put into practice now, would greatly reduce the demand side for statism.

2. Free marketers too often equate private with market or good, and government with regulation or bad. We need to avoid this confusion, esp. wrt to the Too Big To Fail private banks. They are not free market phenomena, and getting them under control will require something — like external audits, investigations for control fraud, and most probably forced breakups. Until this happens they’ll continue to feed off taxpayers. The whole current system of finance is non-transparent, subsidized, and too often a scam.

To Benson: there’s quite a difference between the proposition that free markets work spontaneously, and the proposition that a free market system is likely to emerge spontaneously from a system of state control and regulation. Roger obviously believes the former and not the latter, as do I.

I agree that a problem exists, although maybe Russia is not a good example, as it just turned from cleptocratic socialism to cleptocratic democracy. 🙂

There are many channels through which governments affect societies and markets, and there is often an erosion of social capital in the process, which cannot build up in any way in short notice, neither with design nor with spontaneous evolution. A child cannot become an adult in a week.

Tocqueville’s Americans in 1830 could build their institutions from scrap. Hoffer’s americans in 1950 could build a bridge without an authority. Nowadays americans may be more willing to ask a chinese peasant for a loan. That may be erosion of social capital, which is a long term effect.

One of the many ways through which governments make society fail is by producing at zero cost and making market entry illegal.

A first step may be to enable freedom of entry. At zero marginal price, this would be ineffective, except for low quality or differentiated public (i.e. produced by politics) goods, like high-quality schooling and health care.

Then, a slow increase in prices could do the job. Producers and consumers may start looking for private alternatives, and a demand and supply for private goods may be created. The price increase should not be terminated before removing the need of taxpayers’ money. From that point on, the more efficient would make the day. There wouldn’t be any major shock in the market, except for a short-run increase in prices, if private supply is inelastic and cannot immediately substitute for public supply.

This is only one example, and it doesn’t apply, for instance, to fake physicians (as in the post), although I think that if AMA is not made of fake physicians, they should have a capital of credibility even without state support: they would be the dominant suppliers also in the free market.

I think the mechanism I describe is one of the most important causes of private-supply crowding out in the present society, so it may solve a lot of problems if consistently applied.

For what concerns money, I’m for freezing the monetary base and see what happens: without the Fed intervening to save banks, they should internalize all the costs of their business, instead of hoping for Bernanke to save them. However, in the case of money I see no way to avoid major disruptions. Deleveraging is unavoidable, and may have real effects for at least a couple of years. The US has no strong unions now, so we would have a 1921 (on steroids, given the present state of credit market distortions) and not a 1929. However, there is no limit to political irresponsibility, and I wouldn’t bet on Obama (or, for what matters, the GOP).

I’m not sure how seriously Frederic and Pietro were objecting to my use of Russia as an example. Anyway, I tried to avoid the claim that post-Soviet Russia was ever a “true free market” or anything like that. It was not. But that’s kind of the point. Transition without design is likely to go badly. The fact that policy errors were important sources of trouble tends to support my use of the example, I think. A good design for liberty will reduce regime uncertainty.

I appreciate Frederic’s thoughtful comments. I think they support my view that the issues are complicated and we need to roll up our sleeves and get to work. In NZ you had relatively minor reforms compared to Russia. I would agree that you could push my argument too far and over-design reform. The overall political climate is a factor in deciding how far to push the call for design.

I think licensing restrictions for physicians is a moderately difficult case. It is not trivial, but probably not really that hard either. Here is a more difficult case: Municipal policing. How could we design and institute real competition in municipal policing, including especially the investigation of crimes? I’d love to hear suggestions. How much would it help, for example, to legislate triple damages to the victim? With triple damages, competing private investigators could work on contingency. Would that be the key or largely ineffective? How could you have multiple police forces in the same jurisdiction without violent conflicts among them? It is not enough to imagine how a working system might continue to operate. I ask how you would set it up in the first place. As far as I can tell, that is a hard problem.

Along with everyone else, I commend Roger for his post. A transition from state control to free markets may be different than the spontaneous evolution of free institutions.

Privitization has often followed the wrong strategy, creating private monopolies instead of public. What we need is competition. If necessary, keep the public enterprise in place but open it up to competition. The state enterprise will wither away, like the post office is in the process.

Both municipal policing and judicial functions are being partially eroded by competition. The former by gated communities and homeowners associations; the latter by alternative dispute resolution.

Criminal law is much more difficult. Randy Barnett pointed the way more than the 30 years ago, but there has been no follow up on his ideas. First we must ask: why do we have criminal law?

On Russia: remember that Jeff Sachs first did shock therapy in Poland with success. As already suggested, Russia’s problem may be Russia. That is pretty much what Richard Pipes has concluded. Russia never had private property or any of the institutions that accompany it.

The Russian was handled as a “shock” in part for political reasons — reformers had weak grasp on power, substantial opposition, and what they expected was a short window of opportunity. Contrast with Deng Xiaoping who had substantial support and hence latitude to experiment. The Russians also had “experts” like Sachs arguing that flexible prices, open borders, and stable money are sufficient for a market system, and downplaying the importance of contract and commercial law, independent judiciary, well defined & defended property rights, honest policemen, etc.

Is correct to see a “free society as a spontaneous order that cannot be planned in anyway?” I can’t imagine this is right. So where do the new rules and ways of behavior come from? To suggest we need to think about how to design better rules is entirely different from saying we must centrally plan a society. OTOH, to say we have to sit back and let the free society emerge spontaneously reminds me of Rosen suggesting the “market test” for truth, something yeager correctly took him to task for. “Spontaneous” emergence of rules requires human agency, which can include people designing rules & institutions… even if we can’t see all ramifications, and cannot fully design an overall system. I don’t see any alternative.

Thanks, Jerry. You said, “A transition from state control to free markets may be different than the spontaneous evolution of free institutions.” Just so!

Charles comments suggest (to me at least) how delicate the issues are. We could not have invented the social system we have. In that sense modern “capitalism” and, really, civilization are spontaneous orders. If we try to re-invent everything and start the calendar again at zero it will end badly. The uncomputabilty of policy and of the future

Another example of sudden and relentless liberalization was Estonia. The plan was to drive through the process so fast there would be no time for opposition to coalesce. It worked and Estonia has successfully weathered the global financial crisis.

Estonia had a plan in one sense, but no benefit of a blackboard exercise much less a lab experiment. The new government was aware that low tariffs were important, but those they consulted couldn’t agree on what constituted “low.” So they chose 0.

Roger,
When you get the time, could you write a post on municipal policing and the main issues around it (competition, investigation of crimes, other forensic issues, etc). This is a subject that would interest a lot of people, I think.

Jerry,
Agreed with you on the speed of reforms. Virgil Storr and I (with the help of a PhD students) had started a while ago to look at all the reform processes in the world. We didn’t finish that work unfortunately, but one thing we were hoping to find is that in many cases of successful reforms, speed , not lab experiments, was a definite factor. I can think of NZ, UK, Vietnam, Poland, Estonia, etc. Of course there are counterexamples.

Also do you have any specific Randy Barnett reference on private policing? I know Rothbard wrote a bit on the subject, but I haven’t seen much on it recently (Molinari is of course a reference).

In 1976, Randy Barnett and John Hagel put on an outstanding conference at Harvard Law School on criminal law. At the time, they were just law students themsleves, but got the likes of Alan Dershowitz to participate.

Randy and John’s thesis was that restitution should be the paradaigm for criminal law. Other paradigms were presented, including a brilliant historical paper by Leonard Liggio on the transportation of criminals to frontiers.

The papers were published in Barnett and Hagel, Assessing the Criminal: Restitution, Retribution and the Legal Process (1977). I believe it remains the starting place for reform of criminal law.

More than anything, the problems of transition have to do with what the average person is used to and expects, as Koppl noted. Consulting with psychologists, it seems possible to come up with some annual increment by which the system of control could be decreased without causing societal chaos.

I mean, that’s what we’re talking about, right? Keeping the plebes from burning our mansions down and such?

Um, I guess I don’t “get” your sense of humor, Jeremy. In any event, it’s rather more about getting the state’s boot off the face of the “plebes.” That’s why the criminal justice system is so important. For every Martha Stewart we have thousands of Josiah Suttons.

Well only the second part of my comment was meant to be (partly) humorous. The reason instant free market would be undesirable is because of how dependent the average person is on a state-organized economy. There must be a way to detach from this that is fast enough to have a positive effect but slow enough to allow for a transition period that doesn’t ruin most people’s lives.

As mentioned here, some programs of privatization have succeeded better than others: Estonia, New Zealand, and China have been able to grow private enterprise better than Russia.

I have a hunch about one cause of this difference: The societies in which property rights and entrepreneurship can start to work now, on short notice, are those which have a significant history of such institutions. I suppose that in China and Estonia, 80-200 years ago, there was a significant population of business owners and operators. Whereas Russia lacked such a population, I suggest. To solidify my claim, we would need to be able to examine history in a way that brought out a measure of the extent of private property and entrepreneurship.

Some of the discussion has been abstract and not fact-focused. I echo the call for focusing on specifics and keeping history in mind.

Almost President Reagan’s first act was the Decontrol of Crude Oil and Refined Petroleum Products by Executive Order 12287 on January 28, 1981. It is a very short document and ends with “this Order shall be effective immediately.” It was a huge success: shock therapy for the energy industry.

Right on, Jerry. Details matter. Facts matter. I try to pay attention to facts and details in my work on forensic science. As you know, Pete Boettke has paid attention to facts and details in his work on transition Russia. Here’s something of an overview:

Great topic Roger. With regards to details, the (partial) deregulation of electricity markets provides plenty.

There are three pillars to electricity markets – generatation, transmission, and retail. Deregulation has usually proceeded by opening up the first and third pillars to competition, probably because they are the low hanging fruit. In all the cases I am familiar with, transmission has always remained a regulated entity.

The examples of generation dereg that I am familiar involve the state forcing the incumbent private generators to sell a portion of their existing plant capacity to new participants, and subsequent to this free entry into the production market. Second, all participants are obliged to sell their production into one pre-designed market, a market set up by the state, and sometimes run by them. Those who love freedom may find this a tough pill to swallow, since the coercive power of the state is being used to 1. oblige the transfer of assets from one entity to another. 2. oblige producers to sell in one market rather than allow choice.

The retail side has been opened up by allowing free entrance into the pool on the part of buyers. These retailers contract to purchase electricity from the market, then deliver it to end users, providing transactions details, customer service, etc.

The middle component is the toughest to free up. Usually one organization dominates transmission. It is difficult to conceptualize how one would sell off parts of the wire system without creating a number of mini-monopolies. Allowing free entry into transmission may not be sufficient to promote competition since wire networks are very expensive to create.

So to sum up, deregulation of electricity seems to have proceeded piece-meal, with the easiest parts of the system set free. By no means do we have deregulated markets, since transmission is the toughest component to let loose without causing massive distortions. Lastly, those who have deregulated the market have used the very powers of the state – force and coercion – that libertarians so deride. But given our example, these may be the very tools necessary to facilitate the process.

I think others have made a similar point but it bears repeating. If we beleive that free markets are “best” then we are saying that there is no system superior to the free market, that’s what “best” means. If during a transistion phase you create a system that you feel is “better” than the free market for whatever reason you are saying that there is a system superior to a free market, this is contradictory to our earlier position. If the free market is indeed “best” then why would we choose to allow/implement a system that was less than “best”. If the answer is that there is a set of conditions that makes another system better than the free market then we must re-examine how we decide what is a good system and what is not.

It is my position that the free market will handle a transition or any other phase better than any other system. I say this not because there will be no problems with a free market, there undoubtedly will be. The measure of good and bad however is not whether there are problems or not, but rather whether it is moral or not. Only free markets are moral because only free markets allow people to interact by voluntary consent without coersion. The fact that there are consequences both good(improved choice and standard of living) and bad(charlatans etc.) to free markets are secondary to their nature as the only moral system. If those of us who support free markets focus on the practical aspects and cede the moral arguments to our opponents; those in favour of the involvement of the state will always have a reason to restrict the free market.

‘If we beleive that free markets are “best” then we are saying that there is no system superior to the free market, that’s what “best” means.’

Chris, I bet Roger understands the definition of ‘best.’ But isn’t it the obvious case that markets are ‘best’ at somethings and far from ‘best’ at others? Does anyone on this thread, say, charge their children for their food? Their elderly parents for each visit?

“If during a transistion phase you create a system that you feel is “better” than the free market for whatever reason you are saying that there is a system superior to a free market, this is contradictory to our earlier position.”

Even if, contrary to fact, your first point were true, your second would not follow. It might be ‘best’ if a heroin addict were completely clean, but it also might kill him to move immediately to the ‘best’ regime — he might have to be brought off of the drug slowly. There is nothing in the least contradictory about holding what is ultimately best and what is best right now are different.

First, I don’t think “the free market” is a clear concept. Any market will have a set of formal and informal rules that make it run. In a general sort of way we can say what sort of rules “the free market” must have to be, well, free. But there is an effectively infinite set of particular rules consistent with general notions such as voluntary exchange and clear and coherent property rights. Thus, if we were more punctilious logicians we would not speak of “the” free market at all.

Second, if I have understood your general views on the morality of markets, then I do not share them. I am a consequentialist. If socialism “worked” in some sense, then I’d be a socialist. Indeed, I think the socialist moral vision has lots going for it. John Donne and all that. But theory and evidence suggest that only commercial society really delivers the goods. That is, only commercial society feeds the masses, clothes them, liberates women, reduces violence, and so on. Pete Leeson has a nice piece on the recent evidence for this claim.

He picks up on Shleifer’s “The Age of Milton Friedman” (Journal of Economic Literature, 2009, 47: 123- 135). Not surprisingly, dear old Adam Smith had the point long ago. Speaking of “the very meanest person in a civilized country,” Smith said,

“Compared, indeed, with the more extravagant luxury of the great, his accommodation must no doubt appear extremely simple and easy; and yet it may be true, perhaps, that the accommodation of an European prince does not always so much exceed that of an industrious and frugal peasant, as the accommodation of the latter exceeds that of many an African king, the absolute master of the lives and liberties of ten thousand naked savages.”

BTW: While Smith uses language now correlated to racist and racialist views, he makes a full on attack against racist and racialist views in chapter 2 of the Wealth of Nations. But I digress!